Fiduciary vs. Suitability? What’s the Big Deal?

This subject may feel a bit old and tired at this juncture, but we want to look through a different lens.  It has been nearly thirteen years since Dodd-Frank passed and supposedly gave powers to the SEC to implement the fiduciary standard on Broker Dealers/Registered Representatives.  As we know, this implementation has not occurred and has faced significant backlash from the Broker Dealer community.  So, why has the BD community fought so hard?  Profits and liability!  While much time and many articles have focused on the profit explanation, this RiskTip will focus on the differences in liability experienced by those under a fiduciary duty of care and those under the suitability requirement which currently governs the BD/Registered Representative.

First, it is important to revisit the definitions /concepts:

Fiduciary – An individual in whom another has placed the utmost trust and confidence to manage and protect property or money. The relationship wherein one person has an obligation to act for another’s benefit. (http://legal-dictionary.thefreedictionary.com/fiduciary+duty)

Fiduciary Duty – A fiduciary duty is a legal duty to act solely in another party’s interests. Parties owing this duty are called fiduciaries (All RIAs/IARs). The individuals to whom they owe a duty are called principals. Fiduciaries may not profit from their relationship with their principals unless they have the principals’ express informed consent. They also have a duty to avoid any conflicts of interest between themselves and their principals or between their principals and the fiduciaries’ other clients. A fiduciary duty is the strictest duty of care recognized by the US legal system. (Cornell University Law School)

Suitable – Appropriate to a purpose or an occasion. (http://www.thefreedictionary.com/suitable)

Suitability Requirement – FINRA Rule 2111 requires that a firm (Broker Dealer) or associated person (Registered Representative) have a reasonable basis to believe a recommended transaction or investment strategy involving a security or securities is suitable for the customer. This is based on the information obtained through reasonable diligence of the firm or associated person to ascertain the customer’s investment profile. (FINRA Website)

Disclaimer, I am not a securities defense attorney, but it is clear that one would have much greater odds defending an investment professional under the suitability requirement as compared to the fiduciary duty.   The language is drastically different, “…legal duty to act solely in another party’s interests.” And “…strictest duty of care recognized by the US legal system.”  v. “…a reasonable basis to believe a recommended transaction or investment strategy involving a security or securities is suitable for the customer.” And “…reasonable diligence…”!   One can draw up multiple scenarios where a strategy is suitable yet not solely in the other parties’ best interest and avoiding all conflicts of interest.  A Proprietary security with a big commission is the classic example but there are much further reaching consequences as well.

An additional key implication around the increased burden/cost of fiduciary based claims is that they regularly drag on for months and often years.  This means legal bills accumulate as the clock continues to tick.  As a mentor to our firm would say, “The good thing about fiduciary claims is that they’re hard to prove.  The bad thing about fiduciary claims is that they’re hard to prove.”  In other words, fiduciary claims are a legal expense nightmare, but on the bright side fiduciaries often “win” the suit in the end.  Even still, legal costs are very rarely ordered to be paid by the plaintiff/client.  Proper liability insurance will pay these expenses, yet the drain of going through such an event is indeed taxing.

As always, Golsan Scruggs remains committed to the RIA community and are here for expanded questions and discussions.

Golsan Scruggs is an insurance brokerage firm operating throughout the United States specializing in investment advisor E&O errors & omissions insurance (aka professional liability insurance) for RIA registered investment advisors. As one of the largest insurers of RIA firms in the U.S., we have a dedicated staff that understands the risks of the financial services industry and delivers superior results.  We make the underwriting process painless.

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